Scope of Angel Tax Expanded

What’s in today’s article?

• Why in news?
• What Is Angel Tax?
• What was the rationale behind introducing Angel Tax?
• Which investments used to fall under the ambit of Angel Tax?
• What is the proposed change in Budget 2023-24 with respect to angel tax?
• Why are the possible impacts of the new proposal?

 

Why in news?

• In Budget 2023-24, the government has proposed to extend the so-called 'angel tax’ provisions to transactions involving foreign investors.
• According to the proposal, the excess premium received on sale of shares by an Indian unlisted company to a foreign investor will be construed as “income from other sources” and subject to tax.

 

What Is Angel Tax?

• Angel Tax is a term basically used to refer to the income tax payable on the capital raised by unlisted companies via the issue of shares through off-market transactions.
• This tax is levied on the capital raised via the issue of shares by unlisted companies from an Indian investor if the share price of issued shares is seen in excess of the fair market value of the company. 
• The excess realization is considered as income and therefore, taxed accordingly.
  • E.g., If the fair market value of a start-up share is Rs 10 apiece, and in a subsequent funding round they offer it to an investor for Rs 20, then the difference of Rs 10 would be taxed as income.
• Angel tax gets its name from the wealthy individuals (“angels”) who invest heavily in risky, unproven business ventures and start-ups, in the initial stages when they are yet to be recognised widely.

 

What was the rationale behind introducing Angel Tax?

• Rule related to Angel Tax is described in Section 56(2)(viib) of the Income Tax Act, 1961. 
• This clause was inserted into the act in 2012 to prevent laundering of black money, roundtripping via investments with a large premium into unlisted companies.

 

Which investments used to fall under the ambit of Angel Tax?

• Before budget 2023-24, angel tax was imposed only on investments made by a resident investor. 
  • I.e., it was not applicable in case the investments are made by any non-resident or venture capital funds.
• Allaying the concerns of the startup community, the govt had also exempted investments made by the domestic investors in companies approved by an inter-ministerial panel from Angel Tax.
  • I.e., Government recognised startups, upon meeting certain criteria, were exempted from this tax.

 

What is the proposed change in Budget 2023-24 with respect to angel tax?

• The Finance Bill, 2023 has proposed to amend Section 56(2) VII B of the Income Tax Act.
• With this, the government has proposed to include foreign investors in the ambit, meaning that when a start-up raises funding from a foreign investor, that too will now be counted as income and be taxable.
• However, these foreign investors will not need to pay any angel tax while investing in a government-recognised startup in India — similar to the provision for domestic investors.
  • Either of domestic or overseas investors investing in a DPIIT-registered startup will not attract the so-called angel tax

 

Why are the possible impacts of the new proposal?

 

H3: Image caption: Startup funding in 2022

 

• The recent change came at a time when funding for India’s startups dropped by 33 per cent to $24 billion in 2022 as compared to the previous year.
• Foreign investors are a key source of funding for the start-ups and have played a big role in increasing the valuation. 
  • E.g., Tiger Global, one of the most prolific foreign investors in India, has invested in over a third of the start-ups that have turned unicorn, with a valuation of at least $1 billion.

• Fear among startups
  • The imposition of angel tax hinges on the fair market valuation of the company.
  • This has been a bone of contention between startups and the income tax department.
    • The tax department goes by the rule book and calculates market value based on the net assets of the company. 
    • However, estimated growth prospects of the startup and future projections based on these growth prospects are major factors in determining the fair market valuation of the startup.
  • Hence, the new proposal would further increase the trust deficit in the startup ecosystem.
• Impact on FDI inflow
  • The proposed tax might deter the foreign investors as they may not want to deal with additional tax liability by virtue of their investment in the startup.
  • This in turn will affect the FDI flow in India.
• Creates issues with multiple valuation methods
  • The proposed tax will also create issues with multiple valuation methods for FEMA (Foreign Exchange Management Act) and tax purposes.
    • The Foreign Exchange Management Act (FEMA) 1999 is legislation which regulates the inflow and outflow of foreign exchange. 
    • It came into force on 1st June 2000.

 

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Q1) What is FEMA – Foreign Exchange Management Act?

The Foreign Exchange Management Act (FEMA) is legislation which regulates the inflow and outflow of foreign exchange. It came into force on 1st June 2000. The objective of FEMA is to regulate all aspects relating to foreign exchange. FEMA was brought as a replacement to the Foreign Exchange Regulation Act (FERA). 

 

Q2) Who are Venture capitalist?

A venture capitalist (VC) is a private equity investor that provides capital to companies with high growth potential in exchange for an equity stake. This could be funding startup ventures or supporting small companies that wish to expand but do not have access to equities markets.

 

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Source: Why proposed change in Angel Tax has rattled Indian start-ups?  |  Times of India  |  Outlook Money